Washington (Jan. 12, 2004) -- An Internal Revenue Service directive that companies flag returns submitted through its Free File Alliance has prompted one vendor-member to pull out of the consortium, while industry giant Intuit says it won't comply.

The Free File Alliance was launched last year as a public-private partnership between the IRS and tax preparation software companies with the goal of increasing the number of people who file their taxes electronically by offering free tax prep services to certain taxpayers. Last year, 53 million returns were filed electronically, out of nearly 132 million returns. The Free File Alliance accounted for 2.8 million.

"We're pulling TaxBrain out of the Free File Alliance because we felt it was an infringement on the privacy of those individuals who wanted to take advantage of offers by the tax industry," said Charles Petz, vice president of software development for Petz Enterprises, the owner of TaxBrain.

"We went through a long and difficult debate last summer on the issue, and we're still not sure why the IRS wants to know who these people are. We feel there's information gathered in the tax filing process that's beyond the scope of administration of the tax law, and someone has to draw the line somewhere," Petz said.

Meanwhile, Intuit's TurboTax said that it will remain in the Alliance but won't comply with the IRS directive to tag the free e-filers who use its TurboTax software.

"The debate about the electronic flagging of returns has been ongoing, and Intuit has told the IRS we can't comply because we believe it would compromise the privacy of our customers and that's something we just won't do," said company spokesperson Julie Miller. "The operating agreement we signed did not include the requirement to flag returns, but we have the full intent to continue to offer our free online tax services to disadvantaged and underserved taxpayers, because that's the purpose of the Free File Alliance."

CCH spokesperson Leslie Bonacum said the Riverwoods, Ill.-based company will continue in the alliance with its CompleteTax offering.

Another alliance member, Randolph, N.J.-based TaxSimple, sees no problem. "We don't object to the IRS collecting such information because it doesn't matter whether the government knows if a return came to them through the Free File Alliance or by other means," said TaxSimple president John Vora. "I'm sure that the government has already discussed the privacy issues. My understanding is that they have cleared the issue with the Justice Department."

IRS deputy chief for information technology services Terry Lutes objected to any suggestion that taxpayers' privacy might be compromised. "At the IRS, taxpayers' privacy is protected unequivocally. To suggest differently is flat-out wrong," Lutes said. "We have processed more than 300 million tax returns since the inception of electronic filing and have never once compromised the privacy of a taxpayer."

"There is absolutely no change in IRS policy in identifying tax returns," Lutes said. "Historically, the IRS has tracked return data to assess and project e-file trends, ensure software product accuracy and determine staffing and marketing needs. For years, the IRS has been able to discern returns by software products, returns prepared at our walk-in locations and returns prepared for free at volunteer sites.”

"These same companies already use an indicator identifying their software to the IRS,” Lutes added. “This request, which is pending, is consistent with our current policy and past practices."

-- Roger Russell

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